Sunday, April 22nd, 2012

Infrastructure banks are back in the news thanks to Chicago Mayor Rahm Emanuel’s plan for his billion plus dollar Chicago Infrastructure Trust. This trust would leverage private funds to finance infrastructure improvements in his city. I’m not taking a position on whether or not it is a good idea or a bad one. Partially that’s because I can’t figure out exactly what it is or what its actual value delivered is. This has nothing to do with Rahm’s proposal per se. I was equally confused back when President Obama proposed his National Infrastructure Bank.

The concept, as I understand it, is that an infrastructure bank is some type of investment fund. It collects money from private and in some cases (e.g. Obama’s proposal) public sources. These funds are then invested via some criteria into infrastructure projects that generate some type of financial return such that the original investment can be repaid over time.

So far so good I guess. The question I have though is what does this actually do for us that we can’t already do? Let’s examine some potential sources of value and what infrastructure banks might deliver on them:

1. They might raise funds in a debt constrained environment. In the Chicago proposal, we hear that the city is staggering under a huge debt load such that it can’t borrow any more money without negatively affecting its credit rating. Ok. So explain me this, if private investors put money into a project and expect to be paid back by some revenue stream over time, how is that not debt? This strikes me as very similar to some privatization transactions, which should be basically seen as a type of off balance sheet borrowing. For example, in the case of the Chicago parking meter lease, the city really just borrowed $1.1 billion from Morgan Stanley and is paying it back to them over 75 years in the form of quarters.

I’m not saying these types of financing activities are all bad. But we’ve seen enough of what happens when companies load up with special purpose vehicles and off balance sheet transactions to know that it dramatically reduces transparency. This will make it difficult to assess just how much debt the city has taken on. If the ratings agencies haven’t caught on to this, you can believe they will at some point if more cities shift to these types of financing structures.

Unfortunately, infrastructure banks are often presented as if they are “free money” to the public. I believe this greatly misrepresents the reality. Any money invested by the bank has to be paid back. An infrastructure bank seems to be just another fancy name for borrowing money. We should probably evaluate it just like we do debt.

2. They might be a vehicle for pools of private funds to be invested in infrastructure. There are two items here: private funds and pooling. We already have many ways in which private funds can be invested in infrastructure. The first is called the bond market, which is a well established mechanism. The second is through more traditional public-private partnerships such as privatization transactions, development projects, etc. It’s hard to see how an infrastructure bank uniquely contributes here. There are already ample means for private funds to be channeled to infrastructure.

An infrastructure bank also pools funds from various investors, which has value. But so to bank banks. And so do various purely private infrastructure funds of the type that already invest in toll roads, water systems, etc. It’s hard for me to see any unique value infrastructure banks bring here.

3. They might limit public risk. Potentially the repayment of the investors could be ring fenced to only the revenue streams of the project. For example, any tolls collected on a new toll road. This would be unlike general obligation bonds, which are backed by all the taxpayers of the city.

There’s clearly value here, but there are also other traditional vehicles like revenue bonds that accomplish the same purpose. Revenue bonds may not be the easiest mechanism however, since they typically require a separate contracting entity like a utility or special purpose authority, and investors want to know that there are stable revenue streams to repay them, like sewer fees.

An infrastructure bank might be good where some of these are not available. For example, the project Chicago has highlighted as an example of where to use its infrastructure bank is to retrofit buildings to make them more energy efficient. There may not be an easy way to use revenue bonds for this. Also, the exact energy savings might not be predictable.

In these cases, the investment might look more like equity than debt, since the ability to get repaid is uncertain. I’ve often seen privatizing contracts in this light. They include a hedge against future risk. For example, when Indiana privatized the toll road, they hedged their risk against traffic declines, which in fact happened during the Great Recession.

Of course, to get someone to take on your risk, you are going to have to compensate them. Thus the rates on this type of financing should be higher.

This raises two fundamental risks. The first is whether or not the city overpays a private entity to take on that project risk. The second is that the city might write a terrible contract such that it really doesn’t outsource much risk at all.

I used to crow about how privatization transferred risk to investors. After reading some of these contracts and seeing how they operate in practice, I’m much more skeptical. In practice, most of these contracts ensure that the public retains almost all of the risk associated with the deal. For example, pretty much the only risk the parking meter lessee took on in Chicago was whether or not people continued to put quarters in the slot. Anything else – like hosting a NATO summit that requires meter closures – is the city’s responsibility.

As I noted in my piece “The Privatization Industrial Complex,” cities are pretty much at the mercy of sophisticated investors who do transactions like this day in and day out for a living. Even in a sophisticated financial town like Chicago, multiple contracts have blown up in the city’s face. The idea that somehow governments will do a better job of negotiating deals with an infrastructure bank than they’ve done with other private investors seems dubious.

However, if you can develop a good framework for this, it does show what I think is one clear advantage of an infrastructure bank construct: it sets up a replicable structure through which these types of investments can be made such that you don’t have to make it up from scratch every time.

4. They might promote rational prioritization of investments. This was something Obama touted for his infrastructure bank. The idea is to somehow depoliticize investment decisions and channel money to the highest priority projects. I would agree this might be a valuable thing at the federal level. And we’ve seen some examples of how it can work, such as the BRAC process for military base closures. But Republicans clearly saw the risk that this would become in effect a slush fund for the President to use to reward supporters. The TIGER process I thought showed that there could be a pretty fair allocation of transport funds on a discretionary basis however, though clearly its decisions favored the President’s view of transport priorities.

In any case, given the lack of a clear and easy to understand rationale for why, if these projects will generate funds to repay the initial investment, any government involvement is need to lure in private funds, it’s easy to see why this wasn’t going anywhere, particularly when there is a fundamental disagreement on the vision for transport infrastructure in America (e.g., high speed rail) and on infrastructure spending and the federal role in it generally.

At the local level this seems less valuable. For example, Rahm can already pretty much channel investment anywhere he wants. If we wants a rational allocation of funding to high priority projects, there’s nothing stopping him from soliciting input on what those projects are from various advisors, then making it happen.

5. They might circumvent costly public contracting rules. Privatizing advocates sometimes suggest that for items with large capital expenditures such as highway or airports, private companies can implement these much more cost effectively because they aren’t subject to burdensome public contracting rules. Unlike public officials, who have an incentive to award contracts to their pals, these private companies have an incentive to make money, so they don’t need the legal framework around public procurement.

From an infrastructure bank perspective, I’m not sure how this would work. Is this just a financing activity that otherwise channels money through the normal bidding process? Or is it an entire separate contracting structure. Given that in Chicago the mayor has promised to abide by minority set-aside requirements and such, it seems like the latter.

It’s hard to see how this would be anything new compared to traditional privatization. Also, the public is likely to want many of its key policy goals such as supplier diversity or open records to be followed in any case. And for major construction, I think people are delusional if they think non-union labor is going to be used.

Again, I’m not saying an infrastructure bank is bad, but I’ve yet to see any clear and compelling explanation of the value proposition. It strikes me as just yet another alternative borrowing structure. I’m happy to be shown wrong on this. But if I’m confused, it’s easy to see why lots of other people are too and why there is so much skepticism around the concept. Feedback welcome.

20 Responses to “What Exactly Does an Infrastructure Bank Do For Us Anyway?”

I think you’re absolutely right – the infrastructure bank is simply a way to do these deals en masse without the kind of Ben Joravsky-esque public criticism that dogged the parking meters deal.

That’s something that should worry all Chicagoans. I am possibly the world’s biggest supporter of new infrastructure, for transportation, utilities, recreation, and job growth – but the colossal bungling of the parking meter deal just shows how even one of these deals can tie the city’s hands for decades.

My only thought is that if Rahm ses the connection between infrastructure and economic growth, he might think that the additional economic growth spurred by a given infrastructure project can repay the investors through some sort of value-capture.

Hypothetically, the Red Line rebuild on the North Side will increase property values and spur new construction, so if the city caps property tax revenue and sends any additional stuff to the investors, they can get paid off. Of course, this shortchanges the other city services who need that revenue to cope with the additional population’s demand for services, and there’s no guarantee that infrastructure will magically spark growth.

I gather it is mostly the first reason and the second reason that you gave. Which means there is potential for the problems you outlined.

Ron Utt (PhD) writes about about these matters from a Conservative perspective. I gather he sees the value in theory, but skeptical in practice (even using the words potential slushfund in one piece), especially of the Obama proposal.

The best link is here, although it focuses on states rather than on cities:

“Infrastructure banks are often presented as if they are “free money” to the public. I believe this greatly misrepresents the reality. Any money invested by the bank has to be paid back. An infrastructure bank seems to be just another fancy name for borrowing money. We should probably evaluate it just like we do debt.”

Right, a “bank” looks like another plan to shift liabilities and costs like “public authorities” so the government can spend more money it doesn’t have.

Something has to be done about the way government hides it’s liabilities. Honestly, I don’t see a real fix beyond holding public officials financially responsible in some way for the deals they cut.

This should at least work for the deals that step outside the bounds of any normal accounting methods or engage in the kind of obvious attempts to deceive we see so often at the government level.

“I used to crow about how privatization transferred risk to investors. After reading some of these contracts and seeing how they operate in practice, I’m much more skeptical. In practice, most of these contracts ensure that the public retains almost all of the risk associated with the deal.”

Isn’t a huge factor that major deals are often made when the city or state is in desperate need of cash and in no position to negotiate?

Another huge factor is that usually the public officials want to figure out a private way to retain the status quo–or something as close to it as they can.

For example, with the Chicago parking garage deal, the city had an asset-you doubted they should have owned in the first place. It was an obvious time to throw all or some of the land into the market and let the private sector figure out if it was best used for apartments, offices, retail, parking or some combination of the three. Instead, they tried to figure out a way to get cash without changing the basic structure of things.

John, I think there’s some of that. In the case of the Chicago garages, in fairness, they are underground garages beneath a park, so that’s a consideration. This isn’t a typical offstreet parking deck in a CBD.

Oh, I did assume they were parking decks. Pittsburgh was going to do a deal to sell it’s parking decks. Honestly, I can’t even remember if they did it. There are so many public development authorities, sports Authorities etc.. offering subsidised parking here.

I do think officials prefer deals that bring in upfront cash and leave at least the illusion that nothing big will change.

OK, lease them for some really long term. In this case the deal is proposed to fill the huge pension shortfall.

One interesting thing that came up showed how differently government operates from a business. Private investors wanted to know about expanding possible retail revenue by putting more stores into some of the garages. The Authority basically said they knew nothing about this market since they were legaly obligated to provide parking, period. They were set up to follow a set function, not explore all possible alternative uses for their space.

Thanks for laying this out. My personal (less knowledgeable than I wish I was) feeling from watching the LA 30/10 idea and the push for expanding transit all at once rather than one line at a time as financing comes available is that a region can have an overarching plan for transportation expansion and go to the Infrastructure Bank such that things can get built faster and therefore cheaper when you get rid of the inflation and costs of time with an existing funding source.

It seems that if the bank is a government entity. The interest returned can then be used for more infrastructure investments vs. going to the investors themselves. Sure there are other mechanisms, but this one seems to me more focused on building, rather than just making money for people. If infrastructure construction is a basic function of government, the value might rather come through its value as a service for transportation whether that is transport of water, vehicles and people, or energy rather than its value as an investment return.

Perhaps I’m wrong, but that’s how it seems different to me than bonds and other mechanisms.

The devil is in the details: there is a substantial difference between what an infrastructure bank could offer and what any particular infrastructure bank proposal makes possible.

In an environment where there is an ideological debt constraint that is substantially below the market constraint, then deficit spending in the favor of entrenched incumbent interests may crowd out useful and even necessary infrastructure investment, in which case part of the point of the infrastructure bank is to operate in the margin between the ideological and market constraint on Federal debt issuance.

In an environment where a dedicated tax revenue stream is possible to get passed while a tax revenue fund for the general fund is not, then an investment bank can allow for more flexible finance. For example, an investment bank could offer structured derivatives of a dedicated tax revenue stream such as a sale tax or an crude oil import tariff that is subject to some volatility, where prudence would dictate that only some portion of the proceeds could fund a public bond issue, with the balance having to be disbursed in the year of receipt.

An investment bank also offers the opportunity for more secure pooling of Federal and State resources by providing a structure for multi-year funding of long term infrastructure improvements. This is the key feature of the Regional Development Bank version.

“In an environment where there is an ideological debt constraint that is substantially below the market constraint, then deficit spending in the favor of entrenched incumbent interests may crowd out useful and even necessary infrastructure investment.”

In plain English, that means we need to borrow more to get cash for new investments because we are unwilling and unable to dump prior bad investments in highways, union contracts or entitelment programs.

The money is there, we just lack the will to have adult conversations about priorities.

All of this shows why government is not suited to be makiing infrastructure investments in the first place. The first rule of investing is never to throw good money after bad. The first rule of politics is very different.

America’s great cities were, in many ways, built by private developers, with private money. The building stock, some of the great parks (by donation), the railroads, and most of the mass transit networks were built by private money, for-profit.

Eventually, as time passed, those assets built with private funds became less profitable, and in the case where such assets were viewed as a necessary “public good”, they were eventually taken over by public authorities, am I correct on this one?

So what the infrastructure bank does is something similar, except that the asset being built is ALWAYS in the public’s possesion, the only difference is that private, for-profit money (the engine that made our cities great to begin with since we live in a Capitalist world) will build these assets and extract whatever profit from them that they can, at least (I’m guessing) for a defined period of time until these assets are no longer discernible from other public-funded, public-run assets.

So it’s the same process for city-building as we were doing a century ago, except it’s being done in a more controlled, and perhaps one can argue, retrograde, fashion.

I agree with the general sentiment that this deal was a pretty bad idea. However, I wonder how it will look in 10-20 years when driverless cars become common. There will be a vastly decreased need for parking in the future, and not all that far off.

1. I think part of the confusion with this was purposeful on the city’s part, because of the previous “privatization deals”.

2. I think there is a fundamental misunderstanding of the city’s leasing privatization deals and why they were bad.

“For example, in the case of the Chicago parking meter lease, the city really just borrowed $1.1 billion from Morgan Stanley and is paying it back to them over 75 years in the form of quarters.”

Quite the opposite! Think of it this way: you lose your job so you let your neighbor borrow your car for a week for 100 bucks cash upfront so you can pay your bills. Turns out your neighbor is a realtor and puts 100 miles a day on your car. Bad deal for you, but your neighbor isn’t really loaning you money. The city’s deals on privatization were really terrible. Maybe we should ask why?

Thanks for asking, I’ll tell you why. Because they sold rents. Literally, (read here: http://en.wikipedia.org/wiki/Economic_rent) these are economic rents. The city owns land (the streets), and collects rents from them. Why? Because they are scarce. There is only so much of it, and we can’t really make more on street parking. It is pure economic extraction (ever wonder why the suburbs don’t have metered street parking? Because it isn’t scarce, that’s why). If rents from parking were used to fund some sort of useful monetary stream, like paying for street maintenance (a related activity) then it wouldn’t so much be rents. And it wouldn’t have been a bad deal if the city privatized the collection of rents to a contractor who might modernize rent collection and keep a profit in exchange for funding some sort of city service (like street cleaning). But alas it isn’t. So of course the city’s deals for parking garages and on street parking is a bad deal. These could never be a good deal. They sold rents up front for a wad of cash because they were broke. The new landlords will act less incompetently than the city in extracting rents, and provide no useful stream of revenue for the city for anything. And why would they? And of course the city was going to get a bad deal selling rents. Why would any shrewd businessman buy a lease and not raise rents to gain a profit? How could anyone not see what was coming? It is folly for any municipality to sell, lease, or privatize rents.

But what about the land bank? Hold on a minute, I’m getting to that. First another point of confusion:

“America’s great cities were, in many ways, built by private developers, with private money. The building stock, some of the great parks (by donation), the railroads, and most of the mass transit networks were built by private money, for-profit.

Eventually, as time passed, those assets built with private funds became less profitable, and in the case where such assets were viewed as a necessary “public good”, they were eventually taken over by public authorities, am I correct on this one?”

No, but thanks for asking! The issue is actually rather complicated, especially from a 21st century view. Cities haven’t really taken over much of the buildings, by and large. But cities usual paid for the building of roads. Railroads are kind of nebulous. I mean there was the massive expense of taking the railroad land, which was paid for by the government. And many of these railroads are still owned by private companies and not the government. Even in Chicago. As far as transit goes, it is even more complicated. For example New York’s subways were built using public monies. The city borrowed a staggering sum for its day, and the finished product was owned by the city. The operation of the subways was run by a corporation (IRTC). Chicago had a similar situation. Though the elevated tracks were built by private money, the subway portion was built with New Deal money. By the 40s both New York and Chicago took over operations of their transit infrastructure. In Chicago the private companies could not stay profitable and fell into receivership.

Ok, so what about the infrastructure bank? The city is borrowing money to pay for building stuff. So how is that any different than selling municipal bonds? Well ok now we are asking real questions. The city’s explanation is, well, vague:

it will enable “each project to customize a financing structure using taxable or tax-exempt debt, equity investments and other forms of support.”

So 900 words and this is it? This is all we have to go on? Each project will have customizable financing? How is each project to repay the loan? What sort of projects are eligible for this? How shall it be administered? These are important questions. Do not ask who is behind the curtain. Well ok great and powerful Oz. Because if the city is just going to sell off rents again then the city will just get ripped off again. Like what if the city needed to renovate the Daley Center?

Driverless cars will also increase freeway capacity, potentially taking people from transit.

And while they won’t need to be parked within walking distance of your destination, it would be a giant waste to have them drive all the way back to your house. Perhaps they will drop commuters off downtown and then park themselves in surface lots or on streets in nearby neighborhoods.

The “savings” associated with infrastructure banks will not address the underlying cause of insufficient funding (insufficient tax base for the scale of the project). If there isn’t enough “public” money for the capital costs of an infrastructure project, then they will not have sufficient funding for the operational and maintenance costs, ensuring that the government will be indefinitely paying off its indebtedness, reducing the amount of money on projects which can be paid for through public money.

The tax base should be increased by making it cheaper to build upward rather than outward by changes to zoning (height, minimum setback restrictions, segregation of commercial and residential uses), impact fees (too low for low-density, too high for medium- and high-density) and property taxes (primarily based on the value of the land rather than the value of the building).

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